Asian high yield in the Year of the Rat: 3 signals to watch

The Year of the Rat is associated with wealth and surplus. Ross Dilkes, manager of our Asian fixed income franchise talks about the 3 signals he’ll be watching squarely to generate surplus for the Asian high yield strategies.

05 Feb 2020

Signal 1 for Asian high yield China’s credit impulse

China’s credit impulse measures credit growth as a percentage of gross domestic product (GDP). Simply put, it is a gauge of how easily businesses in China can get loans, a gauge of liquidity conditions in China.

This indicator is a direct reflection of sentiment on the ground and how the real economy is faring. When businesses have access to loans, it spurs the economy as businesses are more willing to buy new machineries and hire more staff.

I monitor this regularly because Asia’s growth dynamics is closely linked to how China is faring. Changes on the credit impulse graph can inform us about the development of business sentiment and the broad environment for Asian high yield investing.

Take for example the third quarter of 2018 where China’s credit impulse was just starting to turn up. While markets in general were still weak and investors preferred defensive bets, we put more money to work in high yield issues around the region. As the liquidity conditions continued to improve towards the end of 2018, we saw a positive tailwind for credit investing in the region. Being early in the cycle was a strong performance contributor to our Asian high yield strategy.

Looking into the Year of the Rat, I do not expect to China’s credit impulse to reach the high points we saw in the 2015 – 2016 periods. While China is not aggressively deleveraging, it continues to keep a tight rein on excessive lending and fine-turning its credit policy. 

This means that my team and I have to be very conscious in allocating risk.

Bloomberg China credit impulse

Source: Bloomberg, as of 31 December 2019

Signal 2 for Asian high yield Low default rate in Asia

Diligent credit research to avoid defaults in payments - whether for interest or principal payments - are key to the success of high yield managers. When a company is unable to meet its regular interest payment, the value of its bond is sold down and will subsequently be a severe drag on portfolio performance.

But even for portfolios that do not invest in the bonds that have defaulted, news of defaults usually have the potential to be contagious. Such uncertainty may potentially leading to general sell-offs in markets.

The good news for Asian high yield investing in the Year of the Rat is that estimates for default rate are low, both by historical terms and in comparison with peers.

Default rates across markets

Source: J.P. Morgan. For illustration purposes only. Data as of 31 December 2019

Markets do not expect default rates to pick up substantially as easing monetary policies in the region are supporting the refinancing ability of companies. We expect the Federal Reserve (Fed) to keep rates low and Asian central banks to very much follow the same path. This helps high yield companies access debt markets easily for refinancing or ongoing operations.

Nonetheless it pays to be prudent as we are approaching the end of a business cycle. Again, it means looking to higher quality issuers and not focus solely on yields.

Signal 3 for Asian high yield Fed moves and reaction of Asian central banks

The Fed left interest rates unchanged at its first meeting for 2020. This is the second time it has left rates unchanged after three rate cuts.

We may see further policy support from the Fed in 2020 but fewer cuts are expected compared to 2019.

In Asia, we saw central banks across Asia lower interest rates in tandem with the Fed’s moves last year. This helped boost sentiments for Asian high yield assets and also gave us tactical opportunities in Asian currencies. 
Looking further into 2020, we still expect the People's Bank of China to cut interest rates to support the economy.  The impact of this move will be positive and widely felt across Asia.

Asia high yield investing in the Year of the Rat

The Year of the Rat is associated with wealth and surplus. To generate surplus in high yield investing this year, me and my team will continue to be flexible in allocating capital and positioning for where we see value. 

At times, we may also tactically position in local markets and Treasuries to effectively risk manage the portfolio. Also we cannot emphasize enough the importance of doing our ground work on the companies we invest in and selecting those that meet with our strict investment criteria.

Note on the coronavirus situation on Asian high yield bonds

With the recent outbreak of the coronavirus in Wuhan, concern has risen around the social and economic impact likely to be felt across the region. Whilst we expect the market impact to be relatively short-lived, the situation is likely to get worse before it eases as we have not reached the peak of infections yet and much uncertainty remains. Having said that, we do not expect the virus to impact longer term fundamentals issuers in Asia high yield bonds and similarly the growth impact to the region remains manageable. 

In terms of portfolio positioning for our UBS Asian High Yield strategy, we continue to be overweight duration, which will help protect portfolio returns in this volatile period.

We remain slightly overweight credit, and see the sell-off in credit markets as a potential buying opportunity. We have also increased our cash holdings in the last two weeks as valuations got richer in the strong start to the year. We wanted to ensure we have a sensible liquidity buffer if volatility persists but also to ensure we have flexibility to take advantage of possibly dislocations in these changing market conditions. Finally we do not have any exposure to Wuhan entities.

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